Risk measurement

Risk measurement

De Lay, Beth

In April 16, the National Credit Union Administration (NCUA) revised its investment rules for credit unions by issuing Interpretive Ruling and Policy Statement No. 98-2 (IRPS 98-2). The effective date was set for Oct. 1, 1998. An IRPS outlines what a credit union should implement; a regulation outlines what it must adhere to.

While the focus in the press has been on eliminating the “stress test” for collateralized mortgage obligations (CMOs), the ruling contains broad language regarding sound practices for managing risk in all investment activities. It’s true IRPS 98-2 eliminates the regulatory requirement for the quarterly stress test for CMOs. The thrust of the IRPS, however, isn’t that these securities don’t need to be monitored, but rather that they should not be singled out as the only securities requiring monitoring. NCUA stated, “The specification of tests on individual securities might have removed the incentive for some institutions to apply more comprehensive analytical techniques at the portfolio level.”

What type of “more comprehensive analytical tools” does NCUA have in mind? IRPS 98-2 outlines several new risk identification practices. Among the items credit unions should consider:

Identify and measure risks associated with a security before its purchase. Evaluate each type of risk on an aggregate balance sheet basis to the extent possible (i.e., combine the credit risk component of investments in certificates with the credit risk component of loans).

Ensure adequate reporting is in place so management and the board can assess the credit union’s risk profile.

IRPS 98-2 also identifies the oversight the board should provide. While most of these “shoulds” are included in regulations requiring compliance, their reiteration in this statement merits a review here. First, the board should ensure management has the skills necessary to manage the risks associated with the credit union’s investment activity. Second, the board should review portfolio activity and ask management to demonstrate that the portfolio is within the guidelines set forth in the investment policy. Finally, in cases where the board does not have an adequate understanding of the investment activity, it should obtain professional advice to enhance its ability to provide oversight.

Having outlined the practices NCUA believes credit unions should adhere to, the agency now needs to decide how it will handle IRPS 98-2 during the examination process. Make sure your credit union is prepared before the Oct. 1, 1998, implementation date.

First, ask management to provide a copy of IRPS 98-2 or obtain a copy from NCUA’s Web site (www.ncua.gov). Then schedule time during an upcoming board meeting to review the statement with management and discuss any necessary enhancements to your current risk management system. If your credit union owns CMOs and has language regarding the stress test in the investment policy, consider altering that language. In some cases, a risk measurement tool, such as stress testing, could be appropriate for the portfolio in aggregate instead of on a bond-by-bond basis.

The message NCUA seems to be sending credit unions is that CMOs aren’t the only securities credit unions buy that have risk. It’s important both management and the board recognize the risks in the investments they hold, develop procedures to measure that risk, and monitor the risk regularly.

Beth De Lay is vice president and senior port folio strategist for Corporate Network Brokerage Services, Inc., Overland Park, Kan.

Copyright Credit Union National Association, Inc. Jul 1998

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